As concerns from the Israeli public continue to grow, this is my 3rd blog on the topic of the new budget proposal from the Israeli Finance Ministry. (Here are the first and second blogs.) If the budget is passed with all of the spending cuts and tax increases proposed, I believe it could be  catastrophic for the Israeli economy. In my opinion, this plan has the potential to financially ruin many thousands of hard working families, cause a significant rise in unemployment, and  not even have the desired affect on the deficit.

To recap, Finance Minister Yair Lapid has proposed (and the cabinet has now approved);

  • Cutting child allowance by about 40%
  • Raising income tax by 1.5% for everyone
  • Raising VAT to 18% (and applying it to fruits and vegetables for the first time)
  • Raising taxes on businesses
  • Taxing stay at home wives
  • Cutting funding for after school care (needed by those who are at work)
  • Possible cuts to the funding of doctor visits and prescriptions (this is not yet clear)
  • New taxes on home purchases that would effect growing families seeking to purchase a bigger home
  • Raising taxes on cigarettes
  • Raising taxes on beer

According to Globes, the effect of these changes would cost the average family at least 7,800 shekels a year! With 1.77 million families (CBS 2009) in Israel, that amounts to almost 15 billion shekels a year! The average Israeli family spends 13,500 shekels a month (Globes / CBS 2010). If the average Israeli family reduces their spending by 7,800 shekels a year, that is an almost 5% reduction in consumer spending. Not only will this mean that many more hard working families will have to do without basic necessities, but the combination of reduced consumer spending together with an increase in taxes on businesses will result in Israeli businesses raising prices, letting go of employees, or even closing down. The Israeli economy absolutely cannot handle this. The ironic affect  is that the government will receive less tax revenue (VAT, business tax, and income tax from those who loose their jobs) when spending goes down.

If we consider that the budget deficit must be closed to avoid other major economic issues, what other options does the government have to reduce the impact on Israeli businesses and families while providing a chance for economic growth? Here are some ideas.

  • Lower the earnings cut off for receiving child allowance. Instead of cancelling child allowance completely for those making 60,000 shekels a month or more, and reducing it by 40% for everyone else, cut people off if they earn 30,000 shekels a month or more and use that savings to make a smaller cut to those making 15,000 or less. For someone making 30,000 shekels a month or more, the few hundred shekels a month in child allowance may be a nice extra, but to people making 15,000, 10,000, or even 5,000 shekels a month, child allowance may mean milk or shoes for their children. Lower income families need to spend this money, and when they do, VAT and business taxes are paid. Higher income families will not change their spending based on child allowance which means the money may sit in the bank and not be spent, which of course means no VAT paid and no benefit to businesses. People must spend money to keep the economy moving. That is the idea behind any economic “stimulus.” As a longer term plan, convert child allowance into a tax credit instead of a handout to encourage more people into the workforce.
  • Increase the quota on natural energy production and encourage investment in this area. It will create more jobs, reduce pollution (and healthcare costs), make Israel more independent, and free up more of our natural gas resources for export, overall increasing the potential investment and tax revenues from the energy sector.
  • Encourage businesses to invest in the Israeli economy. Let businesses get out of the business tax increase if they create enough new positions so that the amount they are saving in business tax is covered by the income tax of those they hire. This will encourage businesses to grow, reduce the number of unemployed Israelis taking unemployment benefits, resulting in less government spending, more people working and buying goods and services from other businesses, and increasing tax revenues.
  • Take more aggressive action on the dollar/shekel exchange rate. A 2011 estimate shows that Israel exports 62.5 billion dollars worth of goods and services annually. A loss of a quarter of a shekel in the exchange rate (and we have lost more than a quarter shekel over the last year) against the dollar translates to more than 15 billion shekels in lost revenues for Israeli exporters. Not only could these businesses be hurting and laying off workers instead of growing and creating jobs, but this translates into a loss of billions of shekels in tax revenues for the Israeli government. These lost billions are now being pulled out of the pockets of Israel’s working class.
  • Make an even bigger increase on cigarette taxes and lower the increase in income taxes or VAT. Cigarettes are a choice, food and rent are not. Not only would this provide some immediate tax relief, but it will lower health care spending significantly in the future for those who will smoke less or even quit over the price increase.

I don’t claim that these ideas are sound solutions. I only aim to start discussion on changing the approach to limit the harm caused to Israeli businesses and families. It is very difficult to look forward to better times 1-2 years from now when so many are already struggling.